Who'll blink this time: the Fed or the market?

Maybe it's time "to accumulate some cash," economist Beryl Sprinkel advises shareholders. He believes that the stock market might take a bad tumble, the result of tightening monetary policy by the Federal Reserve.

Dr. Sprinkel was President Reagan's top economic adviser for his last four years in office.

Before that, he wrote two persuasive books linking Fed monetary policy to the ups and downs of stock prices. They were published in 1964 and 1971.

That link, he says, still holds today.

If the Fed is supplying lots of money to the economy, stock prices subsequently rise. If the Fed is stingy in providing the currency and bank deposits to feed the economy, stock prices tumble.

And right now, notes Sprinkel, the Fed is "in the process of tightening up." Though it is too early to be a meaningful trend, the money supply has shrunk for a few weeks. Partly this is because commercial banks have been getting rid of excess reserves accumulated in the event of Y2K computer troubles.

Most economists figure Fed policy is crucial to the business cycle and thus to stock prices.

"I agree with Beryl," says Mickey Levy, chief economist at Bank of America Securities, in New York. If the Fed tightens, the stock market will "correct."

And Mr. Levy - like many on Wall Street - expects the Fed to push up short-term interest rates a couple of more times in coming months.

"The monetary environment is the single most important influence on the cyclical swings of the equity market," holds William Helman, a New York analyst with Salomon Smith Barney, a major investment-banking firm.

Yet it's recent swings in the stock market that concern Alan Greenspan, chairman of the Fed. In testimony to Congress last month, he stated that "equity values increasing at a rate faster than income, other things equal, will induce a rise in overall demand in excess of potential supply." That situation "cannot persist without limit."

Mr. Greenspan's concern with stock prices bothers Sprinkel. He wants the Fed to concentrate on providing the economy with a steady, modest supply of money to moderate the business cycle and keep damaging inflation at bay.

Sprinkel praises the Fed's stable hand on monetary policy in the past decade. But over the past 12 months, he says the Fed has been a little too generous in supplying money to the economy.

And he's a "little bit scared" that the new Fed emphasis on stock prices will "screw it up."

In the 1920s, Sprinkel notes, the Fed was frightened by the bull market in stocks, braked monetary policy too much, and caused the Great Depression. More recently, he recalls telling President Reagan that the tightening of money by the Fed after 1985 to strengthen the dollar on foreign-exchange markets could cause a recession and a stock-market debacle.

In 1987, the market did plunge. But a recession was avoided.

Similarly, the Bank of Japan, worried by the extreme speculation in Japanese stocks and real estate in the 1980s, put on the brakes hard. Japan is only now coming out of a near decade-long slump.

Anna Schwartz, an economist at the National Bureau of Economic Research in New York, also figures monetary policy is "too lax," allowing the economy to grow at a rate that "should concern the Fed."

If the Fed pushes short-term interest rates to 7 percent, as many forecast, it could sharply reduce economic growth and burst the stock-market bubble, she warns.

Greenspan, now seen as a "miracle man," could be quickly billed as a "destructive force," she says.

(c) Copyright 2000. The Christian Science Publishing Society

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK